Mortgage REITs are Still an Attractive High Yield Dividend Play

Mortgage REITs have garnered increased attention among investors in recent weeks after the Federal Reserve announced stimulus measures focused on the purchases of mortgage backed securities.  The Market Vectors Mortgage REIT Income ETF (MORT), which seeks to replicate the price and yield performance of the Market Vectors Global Mortgage REITs Index, has gained over 20 percent year-to-date.

Mortgage REITs (mREITs) continue to be that right place for high yield investors.  The mortgage REITs are currently at a 4% premium to estimated third quarter book value and yielding 12.0%.  One of the biggest risks to mREITs is increasing mortgage prepayments as the reinvestment risk is higher when interest rate spreads decline.  The latest data suggests that mortgage prepayment rates showed a slowdown in the level of activity in September.

However, we expect increases in speeds in upcoming months given the rally in rates.  We continue to favor the mortgage REITs with prepay protected portfolios as they will have better third quarter book value performance from increased pay-ups on specified pools and more stable cash flows from lower reinvestment needs.  Prepayment speeds on 30-year conventional speeds decreased 11% in September from the prior month. Trends were generally consistent between the 30-year and 15-year sectors.

The best mortgage REIT plays are IVR, MTGE, and ATMG in the next quarter.

American Capital Mortgage Investment Corp. (MTGE) reported net income for the three months ended June 30, 2012 of $32.2 million, or $1.15 per share, and net book value of $22.08 per share.  The Company has a current price to estimated 3Qbook value of 106% indicating it is trading at a 6% premium.  However, American Capital has a dividend yield of 14.72% that has been increased 165% in the last year.

Coverage on American Capital Mortgage was initiated with an Outperform at JMP Securities. The stock price target is $26.50.

Invesco Mortgage Capital Inc. (IVR) reported net income of $79.8 million, or $0.68 per share (basic and diluted), for the quarter ended June 30, 2012 and its book value per share was $18.40.   The Company has a current price to estimated 3Qbook value of 105% indicating it is trading at a 5% premium.  Invesco Mortgage has a dividend yield of 12.54%.

Morgan Stanley recently upgraded Invesco Mortgage from EQUAL-WEIGHT to OVERWEIGHT.  The stock price target is $22.00.

Apollo Residential Mortgage, Inc. (AMTG) reported Net income was $26.4 million or $1.24 per share, for the three months ended June 30, 2012 and its book value per share was $19.65.   The Company has a current price to estimated 3Qbook value of 104% indicating it is trading at a 4% premium.  Apollo Residential has a dividend yield of 16.02%.